JP Morgan Chase CEO Dimon on mistakes leading to $5B trading loss

Monica Langley of The Wall Street Journal offers a deeply researched behind-the-scenes look at the events leading up to JP Morgan Chase's historic trading loss, and its aftermath. Dimon's perspective is fascinating, and to his credit he is pretty clear-eyed about the mistakes made and his involvement in them. Some excerpts:

"The big lesson I learned: Don't get complacent despite a successful track record," Mr. Dimon said in an interview Wednesday. "No one or no unit can get a free pass."...

The stakes are high. Mr. Dimon personally approved the concept behind the disastrous trades, according to people familiar with the matter. But he didn't monitor how they were executed, triggering some resentment among other business chiefs who say the activities of their units are routinely and vigorously scrutinized....

One fascinating theme here is the bank's losing sight of the original mission of the hedging operation:

That year he named Chase executive Ina Drew to head of the Chief Investment Office, or CIO. The unit was responsible for taking charge of the bank's overall risks, and for managing what is now $360 billion of safe, highly liquid securities. Ms. Drew hired Achilles Macris the next year to oversee trading in London, and the CIO group began to expand into riskier derivatives, instruments that derive their value from an underlying financial index or product.

Blessed by Mr. Dimon, the activity originally was designed to provide an economic hedge for the bank's other holdings, executives say. It expanded, particularly after J.P. Morgan in 2008 bought troubled lender Washington Mutual, which held riskier securities and assets that required hedging.

In recent years, some of the group's trading morphed into what essentially amounted to big directional bets, and its profits and clout grew. Last year, Mr. Macris dropped risk-control caps that had required traders to exit positions when their losses exceeded $20 million. Ms. Drew and Mr. Macris declined to comment.

Hedging risky positions (investing some money in a counter-scenario to offset the worst case scenario of certain investments - excellent definition here via Wikipedia) "morphed" into a profit center. The hedges made so much money that they became positions of their own and lost their identity as hedges. This, of course, creates the possibility of a worst case in the other direction, which is what happened to JP Morgan Chase in this situation.

The whole idea of "clout" for a hedge is highly dangerous. A hedge should be dependent on the primary investment you're trying to secure; it shouldn't have any clout.

Hedges are wonderful tools if used rationally. JP Morgan demonstrates, again, that it is impossible to separate investments from the humans that control and depend on them.